Understanding Phantom Stock and Stock Appreciation Right (SAR)

This article will explain why these plans are highly attractive and their differences.

A lot of companies offer their employees with more than just a yearly salary. They also strive to make their staff feel appreciated by giving them something extra in the form of equity plans. Some of these plans companies offer their employees include employee stock purchase plans (ESPPs), stock options, 401(k) plans, and ESOPs.

But there are some companies that would rather play smart and choose a plan that is cost-effective, doesn’t have many regulatory requirements and corporate considerations. Such plans include stock appreciation rights (SARs) and phantom stock plans. These plans are not just attractive to the company, but also for employees.

Phantom Stock – Plan & Structure

The name phantom stock plan was given as this plan has hypothetical units that are used. These units embody “phantom” shares of the company that are given out to those who are participating in the plan. The value of these units increase and decrease along with the company’s share price. In fact, most phantom stock plans come in one of two categories:

Full Value Plans

These plans pay out an employee with the exact stock value at that moment. It pays out considerably more to the employee on a per-share/unit basis. For instance, let us assume that Mary gets 100 shares under this plan, where the share value is $10. After the vesting period of 5 years, the value of the shares reaches $40 per share. So in this case, Mary would be awarded with an amount of $4,000. In short, she gets paid the whole value of the share during the award time.

A table of this vesting schedule for the “full value” phantom stock plan is:

Time PeriodUnits (Shares)
Value per shareTotal ValueTotal Gain
Year 1100$10$1,000$1,000
Year 2100$15$1,500$1,500
Year 3100$20$2,000$2,000
Year 4100$30$3,000$3,000
Year 5100$40$4,000$4,000

Appreciation Only Plans

Under this plan, the employee is paid an amount equal to the value of the growth of the share price over a predetermined period. For instance, let’s say Lilly gets 200 shares under this plan where each share is worth $10, with a 4 year vesting schedule. After the vesting period ends, the value of the shares reach $30 per share. In this case, Lilly would be awarded with an amount of $4,000. How? Well, as it is an appreciation only plan, the complete value is not awarded and only the share increase, which in this case is $20 ($30 – $10). So $20 x 200 shares =$4,000.

A table of this vesting schedule for the “appreciation only” phantom stock plan is:

Time PeriodUnits (Shares)Value per shareOriginal ValueTotal ValueTotal Gain
Year 1200$10$2,000$2,000$0
Year 2200$15$2,000$3,000$1,000
Year 3200$20$2,000$4,000$2,000
Year 4200$30$2,000$6,000$4,000

Both these plans are somewhat like traditional non-qualified plans in many ways. However, these plans are normally subject to a high risk of forfeiture, which ends as soon as the award is offered to the employee. At this time, the employee would have to pay ordinary income tax on the amount they get and the employer can get a deduction for the amount given to the employee that year.

But it should be noted that phantom stock plans do not have the option where an employee can exercise the shares. As per the plan, the employees participating only have to follow the terms and once the vesting period is over, they can get a cash equivalent or the actual stock as the reward based on what deal was made initially with the company.

Stock Appreciation Right (SAR) – Plan & Structure

A stock appreciation right plan is one of the simplest kinds of equity compensation used by companies to offer awards to employees. This plan has some of the follow features that are similar to other plans:

  • The benefits of this plan can be easily transferable to another party.
  • SARs usually have a vesting schedule with rules where the employee has to complete certain goals within some time frame.
  • The plan might have “clawback” provisions. With this the employer might ask for the repayment of all or some of the benefits under the plan if the company goes bankrupt or if the employee leaves to work for another firm.
The overall process of a SAR plan is very simple, and somewhat mirrors other kinds of stock plans in the market. The participants are granted a specific number of rights, after which they can exercise these when they have fulfilled all the requirements, just like non-qualified stock options (NSOs).

Taxation – Phantom Stock & SAR

In both a stock appreciation right plan and a phantom stock plan, employees who get the awards are taxed when their benefits are exercised. Basically, they will have to pay tax on the value of the award minus any amount paid (which is usually nothing in these plans). This amount is taxed at the ordinary income rate for the employee.

And with this, the company gets the benefit of deducting the amount of the award from their tax return. But in case the award is given out in shares rather than in cash, then the amount of the gains is taxable the moment they are exercised, even if the shares have not been sold. And any following gain on the shares is taxable as capital gains.

Phantom Stock vs Stock Appreciation Right (SAR)

Phantom stock plans and stock appreciation rights are two kinds of stock plans that do not use the company stock at all. But they still work as a great reward and motivates employees to work towards increasing the growth of the company.

Phantom Stock

A phantom stock plan basically promises the employees a bonus in the form of either the value of the company shares (full value) or the increase of the share value over time (appreciation only). And the payments of phantom stock are normally given out on a predetermined date.

The taxation of the bonus received through phantom stock is just like other ordinary income. It is taxed as normal income at the time the bonus is given. In short, phantom stock plans have very different rules as compared to the other plans like 401(k)s and ESOPs, since they are not tax-qualified like these plans.

Stock Appreciation Right (SAR)

A stock appreciation right (SAR, in short) is a lot like phantom stock. The only difference in this is that it provides the right to the monetary equivalent of the increase in the value of a specified number of shares, over a specified period of time. Just like phantom stock, stock appreciation rights are paid out in cash, although it does have the option to be paid out in shares too.

SARs can be exercised at any time after they have vested. They are normally offered along with stock options such as NSOs or ISOs to assist in financing the purchase of the options. It is also used to pay tax if there is any due when the options are exercised. Due to this nature of SARs, they are also known as “tandem SARs”.

A great benefit of this kind of plan is that it is highly flexible. But this flexibility is also the greatest challenge. And since it can be created in so many different ways, a lot of decisions need to be made regarding problems based on:

  • Eligibility
  • Who gets the shares
  • How many shares are given to each person
  • The rules for the vesting schedule
  • The rights to participate in corporate governance (if any)
  • The rights to interim distributions of earnings
  • The restrictions on selling the shares, if paid in shares and not in cash
  • Liquidity concerns


From this article we can see that both phantom stock plans and the stock appreciation right plans are a great way for employers to offer their employees compensation. The compensation offered is connected to the company’s stock but the employer does not need to issue any large amount of additional shares for this plan. Due to these advantages, a lot of companies have been using these plans to offer their employees compensation, which in turn helps the company grow.

These plans can be used in your company too! Just ensure that as you do this, you keep track of the plans properly and stay ahead by using an online cap table app. Eqvista is a FREE software that you can use to keep track of your company ownership, issue new plans and manage your company shares. Learn more about the app here and try it out today!

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